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Challenges and Opportunities for the Fall of 2010—Part II

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banace_3 October (Chinavestor) Investors in the U.S. were buoyed by economic indicators pointing to a recovery in September, not to a “double dip” recession as many feared. The Dow Jones Industrial Average (INDEXDJX:.DJI) rose 8.7 percent for the month, the best September for the last 71 years! The index is up 4.4 percent year-to-date (YTD). If that wasn’t enough of good news, consider this: the Nasdaq Composite (INDEXNASDAQ:.IXIC) rose 11.9 percent for the month!

Chinese stocks listed in U.S. exchanges rode on the back of strong market sentiment; the China ADR Index (CAI), compiled by Chinavestor, advanced 4.9 percent in September. The Hang Seng Index (INDEXHANGSENG:.HSI), a go between China and the U.S., was in par with the Dow, climbing 8.9 percent for the month. The rally was universal in Hong Kong, only 2 out of the 42 member Hang Seng Index (INDEXHANGSENG:.HSI) components fell while 40 advanced. Warren Buffet’s showcase Chinese investment, BYD Company (HKG:1211), rose 28.2 percent for the month and was outpaced only by another auto maker, Brilliance China Auto (HKG:1114). Besides autos, energy and airline stocks took the lead for the month. But large cap China Mobile (HKG:0941) (NYSE:CHL), the largest mobile carrier in the world, fell 2.0 percent as investors shunned the sector.

Investors on the Mainland continued to focus on China specific problems, leaving the Shanghai Composite Index (SHA:000001) virtually unchanged for the month. But the index remains deep in the red for the year with a 20.3% loss.

Selected key stocks mentioned in this report: China Vanke (200002), China Mobile (CHL), China Real Estate Information (CRIC), E-House Holdings (EJ), JA Solar (JASO), Trina Solar (TSL), LDK Solar (LDK), Aluminum Corp. of China (ACH), China South Air (ZNH), Baidu.com (BIDU), Home Inns & Hotels Management (HMIN), Sohu.com (SOHU), and Sina Corp. (SINA).

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The government, most notably Premier Wen Jiabao, have been highly critical about the real estate market, threatening additional curbs unless prices fall. Investors went on the defense to hedge their bets up until September 30, the last day of trading. But finally, the government came out with the long anticipated measures posted on an official website on that day, lifting uncertainty. The latest measures include the introduction of a property tax, first in just selected cities but eventually spread out to the whole country; banks are given directive to stop lending on third or more homes. And finally, current regulation extended the 30 percent down payment requirements for all first mortgages, not just apartments of 90 square meters (969 square feet) or more.

The news sent the Shanghai Composite Index (SHA:000001) soaring 1.7 percent, the most since August 17. Real estate and construction related stocks led the rally on anticipation that most of the bad news has already been incorporated in their stock price. China Vanke (SHE:200002), the largest listed property developer in China and Poly Real Estate (SHA:600048), the largest Shanghai listed real estate company, soared on the news.

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While none of these key players are listed in U.S. exchanges, the good news is that U.S. investors have the Claymore/AlphaShares Real Estate ETF (NYSE:TAO) as an alternative investment vehicle to tap into China’s real estate market. As the chart above testifies, there has been a very strong correlation between the performance of the Claymore/AlphaShares Real estate ETF (NYSE:TAO) and China Vanke (SHE:200002).

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But the bad news is that despite conventional wisdom, e.g. the sector is poised to rally as uncertainty is gone, reality says differently. As the chart right abiove testifies, the real estate sector has already been on fire since June, suggesting late comers may have already missed the bus.

The same line of thought suggests U.S. listed property related stocks, such as China Real Estate Information Corp. (NASDAQ:CRIC) and E-House Holdings (NYSE:EJ) just to name a few, are in the danger zone for the short term. By looking at the best performing 25 Chinese stocks listed in the U.S. for September, China Real Estate Information Corp. (NASDAQ:CRIC) is in the top five with a 35.2% return!

While more upside is possible, we’re of a view that the downside risk now exceeds upside potential for the sector.

The soft dollar in September helped push commodity and energy prices higher, sending oil and solar stocks higher for the month. JA Solar Holdings (NASDAQ:JASO), the fourth largest Chinese solar maker by market cap, rose 45.4 percent in September, making it the best performing China play for the month. LDK Solar (NYSE:LDK), a slightly smaller solar maker, rose 32.5 percent followed closely by Canadian Solar (NASDAQ:CSIQ) and ReneSola Ltd. (NYSE:SOL). All these stocks made it to the top twenty five for September.

Our regular readers know that we have been bullish about the solar sector for a long time, keeping selected solar stocks within the Growth and Conservative portfolios. September was no different, we had LDK Solar (NYSE:LDK) in the Conservative portfolio and Trina Solar (NYSE:TSL) in the Growth portfolio, both delivering a great return. We maintain our bullish outlook for mid– and long-term for the sector on fundamentals, but profit taking is going to take a toll on them for the short run. Please pay close attention to Portfolio updates, released at the same time with this Newsletter.

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Strong manufacturing activity coupled with higher commodity prices helped push Aluminum Corp. of China (NYSE:ACH) up 16 percent for the month. We remain bullish about this stock going forward.

Airliners benefitted from industry experts predicting sound profitability for the global airline industry. China Southern Airline (NYSE:ZNH) made it to the top twenty five, a stock also in the portfolios.

Another important observation concerning the top twenty five stocks for September: almost half of them boost a market cap of $500 million or more. This is in sharp contrast to the bottom twenty five stocks where only three companies had a market cap over that threshold.

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The large discrepancy between the composition of the top and bottom twenty five China stocks for September suggests investors fled small cap stock in search for safety. This is well taken considering the latest scandal surrounding Duoyan Printing Co. (NYSE:DYP) and Duoyan Global Water Inc. (NYSE:DGW). Both Duoyan companies fell off the cliff, tumbling 61.4 percent and 38.5 percent, respectively. While investors fled smaller stocks, large cap, top 4 audited internet stocks soared: Baidu.com (NASDAQ:BIDU) is trading above $100 again (after a 10:1 split earlier this year) at new all time highs. The same is true for Home Inns & Hotels Management (NASDAQ:HMIN), another fundamentally solid, large cap NASDAQ stock. Investors of internet household names such as Sohu.com (NASDAQ:SOHU) and Sina Corp. (NASDAQ:SINA) had a reason to cheer in September as well, both stocks delivered over 20 percent returns for the month.

Again, Chinavestor portfolios had three out of these four stocks in the portfolios for the month.

Going forward, we’re cautiously optimistic about smaller names, fully understanding that these stocks belong in the high risk high return category. Looking at the performance of smaller names, it is apparent that two weeks after the disastrous tumble of Duoyan Printing Co. (NYSE:DYP), investors have increasingly returned to the table, picking up selected stocks at bargain prices. High energy prices failed to lift oversold Gushan Environmental Energy (NYSE:GU) and China Integrated Energy (NASDAQ:CBEH) so far, suggesting upside potential exceeds downside risk. Both bio-diesel producers were among the worst performers in September but speculative investors might want to give them a second look.

Quarterly earnings for large cap Shanda Interactive (NASDAQ:SNDA) and Shanda Games (NASDAQ:GAME) fell from last year, putting pressure on the industry. While predictions are always subject to change, we’re optimistic about the outlook for Shanda Games (NASDAQ:GAME) based on a sound game portfolio and pipeline. The stock under $6 looks like a bargain.

New Oriental Education & Technology Group (NYSE:EDU) is another quality company to keep a close eye on going forward.

Blaze Fabry

For previous issue, read: Challenges and Opportunities for the Fall of 2010


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